Aircraft Asset Management: Tools & airline strategies during a world market downturn ATRS World Conference 2010 Paper Darcy Olmos Mancilla, Consultant AirBusiness Academy, 19 av. Leonard de Vinci, 31700 Toulouse, France Phone +33 562 121 139, fax +33 562 121 120 Email address: [email protected]
Contents Abstract...... 2 Introduction...... 3 Background...... 4 Airlines industry analysis...... 5 Airlines business models ...... 5 Airlines world regions revenue and profitability analysis ...... 7 Airlines sample ...... 8 Aircraft asset management tools...... 9 Airlines research sample: fleet ownership and analysis ...... 15 Brand new aircraft: financing and ownership analysis...... 20 Conclusion ...... 21 Appendix A: Top 150 airlines group financial data ...... 23 Appendix B: Airlines research sample’s revenues ...... 24 Appendix C: Airlines research sample’s fleet data...... 25 Appendix D: Lease vs. purchase comparison...... 28 References...... 29
Darcy Olmos Mancilla- ATRS World Conference 2010 1 Aircraft Asset Management: Tools & airline strategies during a world market downturn Abstract
Have airlines changed the way they manage their aircraft during the current economic crisis? In this paper the author reviews aircraft asset management strategies and programmes implemented by airlines in today’s difficult business environment. It analyses the essential aspects of aircraft asset management tools available in the market, looking at the impact on the aviation industry. Through the analysis of fleet data of airlines from different regions and with different business models, the author has identified changes in the way airlines manage their fleets. Indeed, empirical data from latest aircraft transactions, financing and storage numbers evolution suggests a “change of approach” of industry players during this aviation market’s unprecedented crisis. On the other hand, trends in world aircraft ownership suggest an increase in airline fleet flexibility and diversification of the industrial, ownership and operational risks. Furthermore, aircraft values, economic and airline data analysis show a strong correlation between the aviation industry and the world economic situation. Aircraft asset management tools could be an important factor to be taken into account as part of the airline strategy and management decisions, notably during downturns.
KEY WORDS Aircraft asset management, airlines business models, aircraft residual value, aircraft book value, aircraft ownership, airline fleet, operating lease, finance lease, sale and lease back (SLB), Export Credit Agency (ECA), securitization
Darcy Olmos Mancilla- ATRS World Conference 2010 2 Aircraft Asset Management: Tools & airline strategies during a world market downturn Introduction
Aviation is a highly cyclical/GDP correlated industry (Darcy Olmos, 2008), therefore economic downturns put real pressure on aviation industry’s profitability. The current economic crisis has had a non precedent impact on airlines’ net profitability of -$15.9 billions in 2008 and -$9.4 billions in 2009E (IATA, March 2010). On the other hand, the 1,400 or more aircraft due to be delivered this year, together with a normal 400 or so retirements, could boost the in-service fleet 4%, so adding more capacity to the already deteriorated aviation market. However, two thirds of airlines managers surveyed by IATA in April 2010 expect profitability to improve over the next 12 months; concern is building over the rise in fuel cost ahead which may hamper a speedy return to profitability at the industry level. This situation, along with a potential slow recovery on traffic demand, notably in mature markets such as Europe and North America, and increasing cost could create a real challenge to airlines and the way they manage their fleet.
The aim of this paper is to review and analyse aircraft ownership and financing structures (referred to as asset management strategies hereafter) implemented by airlines with different business models and from different regions during the last 5 years and notably during today’s difficult business environment.
To describe airline aircraft management and aviation industry trends, the majority of researchers use industry macro figures such as RPK, load factors and aircraft retirements figures with a strong focus on general aspects. This paper goes further by providing the essential characteristics of the most commonly used aircraft asset management tools and analysing specific airline fleet samples over the last 5 years to identify changes in the way airlines use these tools to respond to the economic crisis.
Through the analysis of statistical data, the author has identified for new aircrafts an increase of ECA support, backstop and SLB transactions notably; and for second hand aircraft a decrease of operating leased aircraft coupled with an increase of aircraft grounding and retirements. On the other hand, no specific asset management pattern was identified among different types of airline business models. For instance, main airlines groups such as Lufthansa, Air France and Iberia despite the fact of being located in the same region; used totally different and sometimes “opposite” aircraft asset management philosophy although each of them have been key industry players for years.
Darcy Olmos Mancilla- ATRS World Conference 2010 3 Aircraft Asset Management: Tools & airline strategies during a world market downturn Background
One of the main risks to be managed when having aircraft on an assets portfolio is the residual or current market value (CMV). Indeed, when comparing the CMV average trend of a representative pool of aircraft and the world GDP behaviour (see figure 1). It is possible to see that aircraft prices mirror the GDP rate of growth trend with a large correlation coefficient of 0.53 (Darcy Olmos, 2009). Consequently, current economic crisis could have negative impact on airlines which decide to dispose of an aircraft under such a distress-crisis situation. Conversely, airlines have the possibility to mitigate this “asset residual value risk” by transferring it to a third party; which is willing to accept and benefit from it by way of keeping ownership of the asset while still giving airline the possibility to operate it under certain conditions and upon a rental payment through the so called operating lease contract. Hence, the risks such as operational, industrial and asset value one can be separately allocated to the airline, aircraft manufacturer and leasing company respectively.
Figure 1: Aircraft Current Market Values (average) vs. GDP (YoY % Ch) (Source: Darcy Olmos ATRS World conference 2009) 6% 10%
World GDP % Ch AVG CMV % Ch YoY 5% 5%
0% 4%
-5% 3% -10% 2%
GDP% Ch -15% CMV % Ch CMV 1% -20% 0% 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -25%
-1% -30%
-2% -35%
From figure 1 it is possible to see that second hand aircraft values are particularly exposed to economic cycles and market fluctuations. On the other hand, airlines analyse the ownership and financing structure they will use for each aircraft delivery months before it happens so as to minimise risk, cost, maximise cash and optimise the aircraft asset management during the asset useful life. Consequently, for new aircraft, economic and market conditions close to each aircraft delivery play an important role when choosing the best asset management tool among the different ownership and/or financing structures,. This can be explained, mainly because economic and market conditions could affect the availability of market liquidity, airlines profitability, cash position, aircraft market values and/or trigger regulation changes.
Darcy Olmos Mancilla- ATRS World Conference 2010 4 Aircraft Asset Management: Tools & airline strategies during a world market downturn Airline industry analysis
Airline revenues grew substantially from $ 346.4 billion in 2000 to $572.4 billion in 2008 1. This increase has been shared differently among different airline types and world regions, consequently an analysis and description of different airline business models and revenue market shared as per region is provided hereafter
Airline business models
By definition a business model describes the rationale of how an organization creates, delivers, and captures value in economic, social, or other forms of value. The process of business model design is part of business strategy.
In theory and practice the term business model is used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies.
Hereafter, a broad description of the main characteristics of the main 5 airline business models:
Mainline carriers : These are mainly network or former flag carriers of States that maintain hub and spoke networks, consolidating traffic at key hub airports.
Leisure airlines : Either travel group or charter airlines. Traditionally these airlines have carried passengers at low unit costs, targeting holiday travellers. Most European charter airlines now form part of vertically integrated organisations incorporating a tour operator, travel agency chain, airline and, often hotels and providers of ground transportation (Williams, 2001). Several charter airlines offer scheduled and seat-only services as a result of competition with Low Cost Carries (LCCs).
Low cost carriers : This business model has evolved in different directions, some airlines keeping to a more solid model involving low frequency services to secondary airport, others adapting to the higher- yielding business market serving higher frequencies.
1 Airlines business top 150 airlines 2008 Darcy Olmos Mancilla- ATRS World Conference 2010 5 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Regional airlines : These carriers tend to operate shorter sectors both point to point and feeding network carrier hubs, usually with aircraft of less than 100 seats (Cranfield University, 2008).
Cargo Airlines : These are airfreight carrier dedicated to the transport of cargo
From figure 2 it is possible to see that the predominant business model in the industry is still the mainline or network carrier group representing 80% of the market share in terms of revenue. On the other hand, LCCs are the second most important business model with 9% market share and with an aggressive year-on-year rate of growth of 19.5% in 2008 (see appendix A). Cargo was the only group with negative revenue growth, which is in line with the higher sensitivity of this segment to the economic cycles and notably trade volumes. In terms of profitability, the top 150 airlines got a negative net profitability margin of -5.8% with all business segments groups in negative position except leisure group that showed a low 1% net margin
Figure 2: Airlines business models and market share (USD Revenues 2008) (Source: D. Olmos of airlines business data)
3% 6% 9% 2%
Cargo - Group Mainline - Group Leisure - Group Low Cost - Group Regional - Group
80%
Darcy Olmos Mancilla- ATRS World Conference 2010 6 Aircraft Asset Management: Tools & airline strategies during a world market downturn Airlines world regions revenue and profitability analysis
As it is possible to see in figure 3, the main aviation sources of revenues are concentrated on 3 regions: Europe, North America and Asia with 31%, 31% and 27% of market share respectively. Other regions such as Middle East, Latin America and Africa represents 5%, 4% and 2% of the market. In contrast, Latin America and Middle East growth 24.7% and 17.2% respectively in line with economic resilience shown by some of the emerging economies located in these two regions. This situation impacted positively air travel demand notably at intra regional level. Conversely, the only region which remained profitable in 2008 was the Middle East with a net profit result of $314 millions representing a 1% net margin over revenues (see appendix A). Altogether, the airlines’ 2008 net margin was -5.8%, with North America, Europe, Asia Pacific and Latin America having margins of -11.1%, -1%, -7.1% and 0.6% respectively.
Figure 3: Airline market shares as per region (USD Revenues 2008) (Source: D. Olmos, airline business data (???))
2% 4% 27%
31% Africa Asia-Pacific Europe Middle East North America Latin America
5%
31%
Darcy Olmos Mancilla- ATRS World Conference 2010 7 Aircraft Asset Management: Tools & airline strategies during a world market downturn Airline sample
Based on public data availability 2 20 airline groups (see appendix B) have been selected by taking into account previous analysis of airline business models and regional importance in terms of revenue market share. Consequently, the airline sample used for the research is focussed on the 3 main regions of Europe, North America and Asia Pacific (see figure3) and two main business models: mainline and Low cost carriers (se figure 2). The airline sample represents 43 % of the market in terms of 2008 revenues.
Figure 4: Airline research sample revenues and intra region market share (USD Revenues 2008) (Source: D. Olmos of airlines business data) (???) revenues % over total region revenues 100 000 70% 90 000 60% 80 000 70 000 50% 60 000 40% 50 000 40 000 30% 30 000 20% revenues Revenues U$m Revenues 20 000 10% 10 000 % of regiontotal total - 0% North America Europe sample Asia Pacific Latin America sample sample sample
1. North America sample Seven airlines (2 mainline, 2 Low cost carriers, 2 cargo airlines and 1 regional) were chosen in line with 31% world market share of this region, as follows: American, Delta, Southwest, Jetblue, FedEx, UPS and Alaska all representing 52% of North American market in terms of revenue (see figure 4)
2. Europe : Four airline groups were chosen in line with 31% world market share of this region, (3 mainline along with regional subsidiaries 3 and 1 Low Cost Carrier), as follows: Lufthansa Group (Lufthansa AG, Swiss, Austrian Airlines, BMI, German wings, Lufthansa cityline, Air Dolomiti, Eurowings and Lufhtansa cargo), Air France-KLM , Iberia and Easyjet all representing 47% of European market in terms of revenue (see figure 4)
2 Airlines annual reports and/or public fleet ownership data of main airlines located either in the Middle East and Africa was not available and 3 See airlines research sample fleet analysis Darcy Olmos Mancilla- ATRS World Conference 2010 8 Aircraft Asset Management: Tools & airline strategies during a world market downturn
3. Asia Pacific Six airline groups were chosen in line with 27% world market share of this region, 6 mainline along with 1 cargo subsidiary (SIA cargo) and 1 regional airline (Dragonair): All Nippon Airways group, Cathay Pacific including Dragon Air, Air China, China Southern, China Eastern all representing 38% of Asia Pacific market in terms of revenue (see figure 4).
4. South America Three airlines were chosen in line with 4% world market share of this region (2 mainline and 1 low cost carrier) as follows: TAM, LAN and GOL Transportes Aereos all representing 60% of South American market in terms of revenue (see figure 4).
Historical public fleet data along with ownership structure was not available for main airlines in the Middle East and Africa
Aircraft asset management tools
Airline industry has some particularities which make it very different from other types of businesses, some of them are very cyclical, competitive, seasonal, regulated, low profitability, capital intensive, cost rigid, highly skilled and sensitive industry. Consequently, airlines face the challenge of managing both operational and aircraft residual value risks along with keeping profitability and fleet flexibility. Hereafter, the author summarizes the main aircraft ownership and financing structures used by the industry in order to take, manage and/or mitigate the risks mentioned above
Direct purchase The situation when airline decides to buy an aircraft directly from manufacturer with its own cash and most of the time keeping the legal title of the aircraft. Under a direct purchase by the airline, normally it keeps ownership of the aircraft which provides airlines the tax benefits of aircraft depreciation and having an asset on its balance sheet which can be used as collateral when raising funds and/or as potential source of liquidity if it is sold. In reality, few airlines have the capability to buy directly with their own cash and therefore losing most of the times the possibility of keeping ownership of the aircraft.
Darcy Olmos Mancilla- ATRS World Conference 2010 9 Aircraft Asset Management: Tools & airline strategies during a world market downturn Some of the most likely airline asset management decisions during economic downturn when owning the aircraft after a direct purchase are:
Ground the aircraft, incurring preservation, parking and maintenance cost without revenue generation Sell the aircraft to another third party normally under distress basis Enter into a SLB transaction with a lessor which could be applicable to either a new or second hand aircraft (see sale and lease back) Sublease the aircraft Access manufacturers asset management support
Figure 5: World fleet in storage (Source: Ascend)
2600 2400 2200 2000 1800 1600 1400 1200 1000 800 600 400 200 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 juil-05
From figure 5 it is possible to see that aircraft in storage tend to increase in periods of economic downturns such as 1991-2-3, 2001-2 and 2008-9-10. Most of these aircraft were parked temporarily and some of them will never come back again into service due to economic performance reasons, regulation or obsolescence. Number of aircraft in storage increased dramatically from 1638 aircraft in 2007 to 2518 aircraft in July 2010 representing a 54% increase.
Darcy Olmos Mancilla- ATRS World Conference 2010 10 Aircraft Asset Management: Tools & airline strategies during a world market downturn Operating lease It is a commercial transaction between an owner (lessor) and a user such as an airline (Lessee), giving the lessee the right, for a given period of time, to operate the lessor’s equipment in exchange for the obligation to pay a rent. It could also be either a dry lease which is a lease of the aircraft, not including crew, insurance and maintenance), dump lease, aircraft including flight deck crew only or wet lease which is typically short term lease for seasonal needs including the aircraft, crew, maintenance, insurance (ACMI), during the period of the lease. An operating lease provides airlines either with the flexibility of getting extra capacity when traffic demand increases or the possibility to return back the aircraft to the lessor 4 when there is not enough traffic demand so transferring the residual value risk of owning the aircraft to the lessor. Additional benefits such as “try before buy” when deciding whether or not to integrate a new type of aircraft into the fleet can be also a plus for an airline
Some of the most likely airline asset management decisions during economic downturn when having an aircraft under an operating lease contract are: Return the aircraft to lessor if lease contract expiration properly scheduled Keep aircraft after negotiation of rental and/or other conditions with lessor
Finance Lease Also called capital lease, it is a contract that transfers the entire benefits and risks incident to ownership of property to the lessee and involves payments of specific amounts during a fixed term sufficient in the aggregate to compensate the lessor’s capital outlay and provide its profit. The term is normally a long duration and the lessee normally acquires the aircraft either because of an option to purchase granted as a term of the lease or as a result of a “put” exercised by the lessor. A finance lease should pose no ownership risks on the lessor, which most of the time is a bank whose sole obligation is to finance the purchase of the aircraft. The main reason for airlines having aircraft under finance lease is to avoid large payments on new acquisitions, cash in on high residual values (upside potential) and/or raise cash by refinancing aircraft (S&LB)
During a market downturn, having an aircraft under a finance lease contract the airline is still intended to pay interest and principal during the lease term; otherwise it can be declared under default by the lessor and therefore it could repossess the aircraft so as to try to remarket it by himself or use a third party to either sell or lease it again.
4 When lease contract properly scheduled Darcy Olmos Mancilla- ATRS World Conference 2010 11 Aircraft Asset Management: Tools & airline strategies during a world market downturn Basically the two types of leases mentioned above are the main two categories from which all other types derive. Nevertheless from an asset risk management point of view, and depending the type of purchase option, finance leases bear the same risk as a direct purchase. Conversely operating lease do not keep the residual value risk with the airline. Therefore, direct purchase/finance lease vs. operating lease will be the main focus of the airline research sample analysis. Indeed, summary table of the main differences between lease vs. purchase are provided in annex D.
Figure 6: World’s fleet ownership (1980 – 2010) (Source: Ascend) 20000 18000 airlines/mortgaged lessors banks 16000 14000 12000 10000 8000 6000 4000 2000 0 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010E Fleet Indeed, the popularity of both operating and finance lease has dramatically increased over the last 30 years (Olmos Mancilla, 2008). Aircraft owned either by Leasing companies and/or by banks have increased 671% from 733 aircraft in 1979 to 8260 aircraft in 2009 (see figure 4) which can be explained among others reason by the benefits of each of these tools mentioned above and by an increase in the awareness and expertise needed for putting in place this and more sophisticated asset management tools which are analysed hereafter.
Sale and Lease Back (SLB) It is a transaction that involves the sale of an aircraft to a purchaser who immediately enters into a lease agreement with the seller for the lease of such aircraft with the purchaser acting as a lessor and a seller acting as a lessee. Through the use of such a structure a seller may recover the capital cost of the aircraft while continuing to have the benefit of its use without any physical disruption in the seller’s operations, which may alleviate a poor cash flow situation caused for instance by an economic crisis environment. Airlines can reduce the risk of future aircraft value fluctuations by selling and leasing back part of a large fleet of similar aircraft, and can lock in a disposal price in contemplation of delivery of a replacement fleet.
Darcy Olmos Mancilla- ATRS World Conference 2010 12 Aircraft Asset Management: Tools & airline strategies during a world market downturn
In summary it is possible to distinguish between two different markets where main characteristics are as follows: • New aircraft – At aircraft delivery, up to 100% of net aircraft price – Prior to delivery, lessor can step in and pay pre-delivery payments
• Old, debt free aircraft – to raise cash (often to solve cash-flow problems) – to transfer residual value risk (e.g. older aircraft) – to realise “hidden equity” in values (when market values are substantially above book values) Figure 7: Ownership of the airline fleet (Source: Ascend)
400
350 Used SLB SLB on Delivery
300
250
200
150
100
50
0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010YTD
From figure 5 it is possible to see the increase of SLB activity during the downturns such as 2001 and 2008-9. Then, it is true mostly for SLBs on delivery (e.g. 2001 and 2009). It is also interesting to see an activity jump in 2007 where economic and market condition were very positive, this situation could be explained for the big amount of liquidity on the market and the willingness of lessor and banks of entering on these kind of transactions
Darcy Olmos Mancilla- ATRS World Conference 2010 13 Aircraft Asset Management: Tools & airline strategies during a world market downturn Governmental support: Export Credit Agencies (ECA) Most industrialized countries have specific governments departments or agencies with the responsibility of developing, promoting and financing export sales of that nation’s products. Through insurance and loan and guarantee programs, the official export credit agencies seek to ensure that, to the extent practicable, sellers of national goods and services that are otherwise internationally competitive remain so when financing of the sale is taken into account. One feature common to all the systems is the assumption, by or on behalf of the government, of the bulk of credit risk inherent in extending finance to foreign buyers. Every system has a specialized institution for this purpose, either an official body or one that acts in the State’s name. Official support, through export credit agencies (ECAs), may be provided as “pure cover” (i.e. insurance or guarantees given to exporters or lending institutions without financing support); as financing support, (i.e. direct credits/financings, refinancing, interest rate support); or as aid financing (credits and grants). Official credit support may be provided with the basic guarantee or insurance facility, or it may be provided on an stand-alone basis. Main ECAs are EXIM bank, COFACE, HERMES, ECGD and EDC for the US, France, Germany, UK and Canada respectively.
Manufacturers’ assistance Manufacturers’ support is, generally, a market-driven factor in aircraft financing. When times are good for the industry, manufacturers’ support is low or non existent, but when times are tough and sales are few, then competition will force manufacturers to take risks that they will normally try to avoid.
Aircraft securitization Is the process by which pools of leases and aircraft are packaged, underwritten and distributed to investors in the form of security instruments known as Enhanced Equipment Trust Certificates (EETC) securitization and portfolio securitization. There are two main types: I. Receivable securitization: where the rentals and other revenues payable pursuant to leases are securitized II. Residual securitization: where the residual value of the aircraft is securitized
Main benefits are: The risk is spread over a number of borrowers The risk may be spread over a number of geographical regions The larger the transaction the lower the transaction cost per unit The loan or asset is removed from the lessor’s or airline’s balance sheet Funding with finer margins are available in the market
Darcy Olmos Mancilla- ATRS World Conference 2010 14 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Although it is an aircraft financing and asset management tools which can provide liquidity for an airline willing to securitize aircraft on its portfolio, it is very difficult to make a detailed ownership analysis and track of SLB’s aircrafts mainly because it could involve external parties such as credit agencies or different investors which public data is not available.
It is making a loan or mortgage into a tradable security by issuing a bill of exchange or other negotiable paper in place of the loan. The term is also known in the aviation industry as the “packaging of aircraft- related receivables into securities for sale to investors”
Airline research sample: fleet ownership and analysis
Based on the airline sample discussed previously, the author analyses their fleet ownership evolution over the last 5 years so as to identify main changes on their asset management strategies before (2007-2) and during economic downturn (2008-9). For some airlines groups, regional subsidiaries fleet ownership data was available: VLM Airlines, Regional, Cityjet and Britair for Air France, KLM Cityhopper the for KLM and Dragon air for Cathay Pacific, therefore the author analysed it as a separate regional carrier. The same criteria was applied to Singapore cargo subsidiary of Singapore airlines.
From figure 8 it is possible to see that airlines implemented different asset management tools and ownership mixes over the last five years (airline ownership philosophy). For instance, airlines such as Lufthansa, Southwest, FedEx and Singapore airlines group decided to take most of the aircraft residual value risk by owning around 80% of their fleet over the last 5 years, which can be explained by the airline’s philosophy and/or the benefits mentioned above (see direct purchase). Conversely, airlines such as Iberia or the Brazilian carriers Gol and TAM had largely used operating leasing as their preferred asset management and ownership tool which also can be explained by the benefits of it (see operating leasing part) and the carrier strategy and philosophy. For instance Iberia openly states that “airlines’ mission is to bring people from point A to B which doesn’t necessarily mean taking the residual value risk of the aircraft” (AirBusiness Academy, Asset Management course 2010). Although the airline research sample represents an important part of the aviation market revenues and most of their members have a sustainable and solid business, the author found no common asset management strategy or philosophy; consequently it is not possible to associate one specific asset management philosophy with airline economic success and/or business sustainability over time.
Darcy Olmos Mancilla- ATRS World Conference 2010 15 Aircraft Asset Management: Tools & airline strategies during a world market downturn Figure 8: Airline research sample asset management & ownership philosophy (2005 – 2009) (Source: D Olmos of companies’ annual reports and SEC data) Cathay Pacific Operating Finance Ow ned Iberia Operating Finance Ow ned American Operating Finance Ow ned
100% 100% 100% 90% 90%
80% 80% 80% 70% 70% 60% 60% 60% 50% 50% 40% 40% 40% 30% 30% 20% 20% 20% 10% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
Easyjet Operating Finance Ow ned Southwest Operating Finance Ow ned Dragonair Operating Finance Owned
100% 100% 100% 90% 90% 80% 80% 80% 70% 70% 60% 60% 60% 50% 50%
40% 40% 40% 30% 30%
20% 20% 20% 10% 10%
0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
Lufthansa Operating Finance Ow ned JetBlue Operating Finance Ow ned Air China Operating Finance Ow ned
100% 100% 100% 90% 90% 80% 80% 80%
70% 70% 60% 60% 60%
50% 50% 40% 40% 40%
30% 30% 20% 20% 20% 10% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
Air France Operating Finance Ow ned FedEx Operating Finance Ow ned SIA group Operating Finance Ow ned
100% 100% 90% 90% 80% 80% 100% 70% 70% 90% 80% 60% 60% 70% 50% 50% 60% 40% 40% 50% 30% 30% 40% 30% 20% 20% 20% 10% 10% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
Air France regional subsidiaries Operating Finance Ow ned UPS Operating Finance Ow ned SIA Cargo Operating Finance Ow ned
100%
90%
80% 100% 90% 100% 70% 80% 90% 60% 70% 80% 50% 60% 70% 60% 40% 50% 50% 30% 40% 40% 30% 20% 30% 20% 10% 20% 10% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
Operating Finance Ow ned Operating Finance Ow ned KLM regional subsidiary Operating Finance Ow ned Alaska ANA
100% 100% 100% 90% 90% 90% 80% 80% 80%
70% 70% 70% 60% 60% 60% 50% 50% 50% 40% 40% 40% 30% 30% 30% 20% 20% 20% 10% 10% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
GOL Operating Finance Ow ned Delta Operating Finance Ow ned China Eastern Operating Finance Ow ned
100%
100% 80% 100% 90% 80% 80% 60% 70% 60% 60% 50% 40% 40% 40% 30% 20% 20% 20% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
TAM Operating Finance Ow ned LAN Operating Finance Ow ned China Southern Operating Finance Ow ned
100%
100% 80% 100% 90% 80% 80% 60% 70% 60% 60% 40% 50% 40% 40% 30% 20% 20% 20% 10% 0% 0% 0% 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 Notes : public data not available for Dragonair and Air China in 2005 and TAM airlines in 2009; FedEX leasing types disclosure not available; Iberia wet leases included on the operating lease part and Delta fleet 2008-9 corresponds to merged fleet of Delta and Northwest.
Darcy Olmos Mancilla- ATRS World Conference 2010 16 Aircraft Asset Management: Tools & airline strategies during a world market downturn
As previously discussed, one of the main airline asset management objectives is to have fleet flexibility to cope with industry cyclicality; market leasing rates take into account supply vs. demand of aircraft for lease which is correlated to economic conditions (Darcy Olmos, 2009) along with aircraft other technical or technological market factors for a specific aircraft type.
Figure 9: Airline jet fleets in service by size category (2010) (Source: Ascend)
Regional Jets; 3270; 18%
Narrow body; 10931; 60%
Widebody; 4095; 22%
From figure 9 it is possible to see that narrowbodies and/or single aisle aircraft such as A320 family and 737s represent 60% of world fleet in service with a value of $197 billions or 47% of world fleet in terms of value (Ascend, 2010). Consequently, these are the most liquid aircraft type (good remarketing potential). Analysing single aisle lease rates could be a good indicator of leasing demand/supply. and properly represent the market conditions as follows
Figure 10: A320 5 lease rates YoY % change (Data source: Ascend)
30%
20%
10%
0%
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9
9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0
-10% 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0
1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 -20%
-30%
-40%
-50%
5 1989 year of build Darcy Olmos Mancilla- ATRS World Conference 2010 17 Aircraft Asset Management: Tools & airline strategies during a world market downturn From figure 10 it is possible to see the cyclical and economic driven behaviour of lease rates for a single aisle aircraft type. Moreover, a dramatic lease rental drop during the last three years suggests a decrease on operating lease aircraft demand over supply, which is in line with the airlines’ right to use the flexibility provided by this asset management tool. As previously mentioned the global operating lease trend has increased dramatically during the last years. Airline by airline, different lease strategies and trends were identified depending on the region and airline itself.
Figure 11: Aircraft under operating lease Europe sample (Source: D. Olmos from airlines annual reports data)
140 Europe: operating leased A/Cs 120
100
80
60
40 numberof A/Cs
20
0 2005 2006 2007 2008 2009 Iberia Easyjet Lufthansa Air France AF regional KLM regional
In Europe apart from Lufthansa 6, airlines from the research sample decreased their number of leased aircraft which is in line with flexibility advantage of this tool. Indeed, most airlines started to decrease the number of aircraft under operating lease in 2009
Figure 12: Aircraft under operating lease North America sample (Source: D. Olmos from airlines annual reports data)
350 North America: operating leased A/Cs 300 250 200 150 100
numberof A/Cs 50 0 2005 2006 2007 2008 2009 American Southw est JetBlue FedEx UPS Alaska Delta
The North America research sample showed a decrease in the number of aircraft under lease in 2007 for legacy carriers American and Delta and since 2008 for the two cargo carriers and Alaska; which is in
6 Lufthansa has recently acquired other smaller airlines which explain the dramatic increase of the total number of aircraft from 534 in 2008 to 732 in 2009. It could also be the main reason of the increase of aircraft under lease due to acquired airlines aircraft leasing legacy Darcy Olmos Mancilla- ATRS World Conference 2010 18 Aircraft Asset Management: Tools & airline strategies during a world market downturn line with the immediate sub prime crisis impact in North America unlike Europe where the impact was months later. Indeed, although Delta merged with Northwest in 2008, it was still possible to see a decrease in aircraft under operating lease in 2009 where figures were comparable with 2008. On the other hand, for years 2008 and 2009 the two low cost carriers Jetblue and Southwest increased and maintained respectively the total number of aircraft in their fleet, which explains the increase or non change on aircraft under operating lease on the same periods
Figure 13: Aircraft under operating lease Asia Pacific sample (Source: D. Olmos from airlines annual reports data)
Asia Pacific: operating leased A/Cs 160 140 120 100 80 60
number of A/Cs number 40 20 0 2005 2006 2007 2008 2009 Cathay Dragon Air Air China SIA Group SIA cargo ANA China Eastern China Southern
In Asia Pacific Chinese carriers along with Singapore airlines increased their fleet size in 2008 and 2009, on the other hand for aircraft under operating lease it either increased or remains the same in line with the resiliency of these emerging markets. Conversely, All Nippon Airways has decreased the number of aircraft under operating lease every year since 2006 and Cathay Pacific decreased dramatically the number of aircraft under operating lease from 18 in 2007 to just 4 in 2008. Consequently, it is possible to see a strong correlation between the local economy performance and aircraft leasing importance.
Figure 14: Aircraft under operating lease Latin America sample (Source: D. Olmos from airlines annual reports data)
140 Latin America: operating leased A/Cs 120 100 80 60 40 numberof A/Cs 20 0 2005 2006 2007 2008 2009 Gol LAN TAM
Darcy Olmos Mancilla- ATRS World Conference 2010 19 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Although a small number of airlines, the Latin America research sample showed different behaviours, for instance Brazilian low cost carrier GOL decreased both fleet and aircraft under lease in 2008 but came back to capacity increase in 2009. TAM has been increasing both total fleet and aircraft under operating lease every year during the 2005-2008 period, all in line with strong economic development in Brazil. Conversely, although increasing total fleet size since 2005 to 2009, the number of aircraft under operating lease decreased in 2008 and 2009.
Brand new aircraft: financing and ownership analysis
In 2005, 2006 and 2007 aircraft manufacturers saw an unprecedented number of orders 7 of 2057; 1840 and 2764 respectively, leading record aircraft deliveries number of 979 aircraft in 2009, despite the deep economic crisis. Airlines normally order new aircraft years before delivery and start looking for the best asset management and financing structures the months previous to aircraft delivery depending on market conditions such as interest rates, margins, LTVs, etc. As it is possible to see in figure 15, between 2005 and April 2010 the popularity of each of the asset management tools described previously change depending the year, for instance 2009 showed a sharp increase on Export Credit Agency (ECA) activity for both airlines and lessors which also remains stable during the first quarter of 2010. On the other hand, there was an increase in manufacturer’s support which can be explained by 2009 economic crisis market conditions such as high volatility, low risk appetite and sometimes lack of liquidity.
Figure 15: Financing of Airbus deliveries (Source: Airbus)
120%
100%
80%
60%
40%
20%
0% 2003 2004 2005 2006 2007 2008 2009 2010 (to end April) ECA Airline ECA Lessor (inc SLB) Commercial SLB Commercial Airline Commercial Lessor Manuf
7 Aircraft over 100 seats Darcy Olmos Mancilla- ATRS World Conference 2010 20 Aircraft Asset Management: Tools & airline strategies during a world market downturn Conclusion
It is possible to see a global economy recovery which follows a 2 speed pace: developing vs. emerging economies. Aviation markets showed signs of recovery at 2 speed also, which is in line with the high correlation found between aviation market and economy conditions (Olmos, 2009). The growth remains concentrated in the emerging markets of Asia, Latin America and the Middle East, with benefits accruing mainly to airlines in these regions. Carriers in the large developed markets of Europe and North America face much more sluggish market growth. On the other hand, this 2-speed recovery in economies, freight and travel markets is reflected in the divergent performance and different asset management tools used by airlines in different regions.
The author found a decrease of aircraft under operating lease during economic crisis, notably on the most affected regions such as Europe and North America, although starting on different years. Conversely, in emerging markets such as Asia Pacific (notably China) and Latin America airlines fleet grew and the number of aircraft under operating lease either increased or didn’t change. Moreover, differences in the use of asset management tools were found among different business models, cargo airlines decreased total fleet during the last 3 years and also decreased or kept the number of aircraft under operating lease unlike low cost carries which increased their total fleet over the last 2 crisis years
The author also found a decrease in lease rates due to decrease in demand for leased aircraft which supports the idea that operating leases are a key management tool during market downturn because it permits airlines to decrease capacity without bearing the aircraft asset value risk. Aircraft in storage increased 54% between 2007 and July 2010. Furthermore, the author found that Sale and Lease Back (SLB) activity increased 48% and 51% for new and use aircraft respectively meaning it is also a popular aircraft asset management tool during economic downturn, notably for airlines affected by decreasing demand and looking to preserve cash during the difficult period.
The airline research sample data analysis showed that airline business sustainability or economic performance is not fully dependent on the airline aircraft asset management strategy (measured by fleet ownership mix trend), which rather reflects airlines’ tolerance to asset and/or market risk based on estimation of potential future cost and benefits of each asset management philosophy. Lufthansa for instance implemented over the last 5 years a very conservative approach by owning around 80% of its fleet therefore renouncing the flexibility benefits of operating lease. This asset management philosophy
Darcy Olmos Mancilla- ATRS World Conference 2010 21 Aircraft Asset Management: Tools & airline strategies during a world market downturn could be explained by either one or more of the following reasons: have asset on airline’s balance sheet so as to use them as collateral or argument when raising fund on the market, support a good airline credit rating or take benefit of depreciating the aircraft notably when airline is in profit. Moreover, having a tier one recognised maintenance provider like Lufthansa Technik provides the necessary technical support which could benefit aircraft residual values. On the other hand, during the same period of time Iberia showed a very leasing oriented airline asset management strategy having more than 80% of the fleet under operating lease in 2009, although the airline has been profitable during the last years until 2008.
For new aircraft deliveries data analysis showed that asset management tool preferences are more dependent on market liquidity availability and airlines and lessors financing needs which is supported by the increase of both Export Credit Agencies and manufacturer support activity during current market downturn.
Consequently, aircraft asset management tools could provide airlines with flexibility and other valuable benefits, notably during a market downturn although they don’t completely determine the airlines’ economic success. Aircraft asset management’s tools are also an important factor to be taken into account, notably during market downturns and as part of the airline strategy and management decisions.
Darcy Olmos Mancilla- ATRS World Conference 2010 22 Aircraft Asset Management: Tools & airline strategies during a world market downturn Appendix A: Top 150 airlines group financial data Source: Airline business 2008 2007 2006 2005 2004 2003 2002 2001 2000 Revenues $ billion 572.4 546.6 488.7 439.9 392.3 341.0 318.7 312.7 346.4 Operating result $ billion -15.1 29.2 20.4 10.3 9.6 2.9 0.0 -5.7 13.7 Operating margin percentage -2.6% 5.3% 4.2% 2.5% 2.6% 0.9% 0.0% -2.0% 4.2% Net result $ billion -33.2 22.2 2.1 -20.7 -3.1 -6.8 -8.8 -12.6 3.5 Net margin percentage -5.8% 4.1% 0.4% 5.1% -1.3% -2.2% -2.9% -4.2% 1.1% Note: *Years before 1997 apply to the Top 100 only and 1999 is rebased on the current table. 1999 1998 1997 1996* 1995* 1994* 1993* 1992* Revenues $ billion 320.0 299.1 293.2 281.4 272.9 244.9 228.7 224.6 Operating result $ billion 1.6 19.3 20.5 14.0 15.5 10.9 4.4 0.3 Operating margin percentage 5.3% 6.8% 7.2% 5.0% 5.7% 4.5% 1.9% 0.1% Net result $ billion 8.7 9.0 9.3 5.4 1.7 -0.2 -1.3 -8.0 Net margin percentage 3.0% 3.1% 3.2% 1.5% 2.1% -0.1% -0.6% -3.6%
Top 150 airline groups summary by type 2008 Group type Revenues change Op result Op margin Net result Net margin
Cargo - Group 37 077 -0.6% 1 163 3.1% -103 -0.3% Mainline - Group 458 039 8.1% -18 156 -4.0% -32 076 -7.0% Leisure - Group 12 593 20.8% 265 2.1% 121 1.0% Low Cost - Group 49 014 19.5% 1 351 2.8% -977 -2.0% Regional - Group 15 697 5.9% 306 2.0% -170 -1.1% Grand Total 572 420 8.6% -15 070 -2.6% -33 205 -5.8%
Top 150 airline groups summary by region 2008 Region Revenues change Op result Op margin Net result Net margin Africa 10 373 5.1% 93 0.9% -66 -0.6% Asia-Pacific 153 741 8.6% -4 532 -2.9% -10 924 -7.1% Europe 176 490 9.0% 1 774 1.0% -1 790 -1.0% Middle East 31 181 17.2% 1 117 3.6% 314 1.0% North America 177 723 5.2% -14 820 -8.3% -19 748 -11.1% Latin America 22 911 24.7% 1 298 5.7% -992 -4.3% Grand Total 572 420 8.6% -15 070 -2.6% -33 205 -5.8% Darcy Olmos Mancilla- ATRS World Conference 2010 23 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Appendix B: Airlines research sample’s revenues
North America sample Asia Pacific sample Europe sample Revenue Revenue Airline group $m Airline group $m Airline group Revenue $m AMR Corporation 23 766 ANA Group 13 883 Lufthansa Group 36 533 Delta Air Lines 22 697 Cathay Pacific & Dragoin Air 11 124 Air France-KLM Group 33 739 FedEx 22 364 Singapore Airlines & cargo 11 101 Iberia 8 101 Southwest Airlines 11 023 China Southern Airlines 7 983 easyJet 4 649 United Parcel Service 5 800 Air China 7 640 Total sample 83 022 Alaska Air Group 3 663 China Eastern Airlines 6 028 % of region revenues 47% JetBlue Airways 3 388 Total sample 57 759 Total sample 92 700 % of region revenues 38% % of region revenues 52% Latin America sample Airline group Revenue $m TAM Linhas Aéreas 5 797 Summary LAN Airlines 4 534 North America sample 92 700 52% GOL Transportes Aereos 3 506 Europe sample 83 022 47% Total sample 13 836 Asia Pacific sample 57 759 38% % of region revenues 60% Latin America sample 13 836 60% Total samples 247 318 % world 43%
Darcy Olmos Mancilla- ATRS World Conference 2010 24 Aircraft Asset Management: Tools & airline strategies during a world market downturn Appendix C: Airlines research sample’s fleet data
Leases EUROPE Owned Finance Operating Wet Total Iberia 2005 46 14 89 6 155 2006 45 14 82 9 150 2007 36 9 87 5 137 2008 16 11 89 3 119 2009 8 11 90 0 109
Easyjet 2005 18 91 109 2006 38 6 78 122 2007 55 6 76 137 2008 75 6 84 165 2009 107 6 68 181
Lufthansa 2005 339 22 71 242 2006 351 11 68 250 2007 396 9 108 264 2008 420 8 106 534 2009 571 26 125 722
Air France 2005 141 23 90 254 2006 151 17 90 258 2007 164 12 85 261 2008 161 12 90 263 2009 162 12 88 262
AF regional 2005 28 51 54 133 2006 30 50 55 135 2007 47 47 50 144 2008 71 41 47 159 2009 70 38 45 153
KLM regional 2005 19 20 14 53 2006 27 18 8 53 2007 33 14 8 55 2008 33 14 8 55 2009 50 3 6 59
Darcy Olmos Mancilla- ATRS World Conference 2010 25 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Leases North America owned Finance Operating Wet American 2005 395 91 213 699 2006 398 89 210 697 2007 387 84 107 578 2008 369 76 226 671 2009 349 80 220 649
Southwest 2005 352 9 84 445 2006 388 9 84 481 2007 425 9 86 520 2008 446 9 82 537 2009 440 9 88 537
JetBlue 2005 61 31 92 2006 70 2 47 119 2007 77 4 53 134 2008 83 4 55 142 2009 92 4 55 151
FedEx 2005 557 113 670 2006 565 106 671 2007 569 100 669 2008 581 96 677 2009 567 87 654
UPS 2005 268 309 577 2006 282 325 607 2007 268 311 579 2008 262 309 571 2009 267 298 565
Alaska 2005 62 48 110 2006 70 44 114 2007 64 51 115 2008 75 35 110 2009 79 36 115
Delta 2005 403 43 203 649 2006 369 65 166 600 2007 359 82 137 578 2008 684 81 258 1023 2009 677 93 213 983
Darcy Olmos Mancilla- ATRS World Conference 2010 26 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Asia Pacific owned finance operating wet Total Cathay 2005 29 54 13 96 2006 39 49 14 102 2007 45 49 18 112 2008 49 48 4 101 2009 48 49 29 126 Dragon Air 2005 na na na 2006 12 5 20 37 2007 15 4 20 39 2008 13 2 20 35 2009 10 2 17 29 Air China 2005 na na na 0 2006 97 47 48 192 2007 103 59 58 220 2008 107 76 60 243 2009 119 77 66 262 SIA Group 2005 87 5 22 114 2006 88 5 25 118 2007 85 4 32 121 2008 89 4 33 126 2009 88 4 39 131 SIA cargo 2005 8 5 1 14 2006 8 5 3 16 2007 5 4 5 14 2008 5 4 5 14 2009 3 4 5 12 ANA 2005 98 89 187 2006 109 87 196 2007 125 86 211 2008 136 82 218 2009 139 71 210 China Eastern 2005 105 64 169 2006 107 79 186 2007 139 75 214 2008 157 75 232 2009 China Southern 2005 110 65 86 261 2006 309 81 123 309 2007 332 69 130 332 2008 142 60 146 348 2009 175 55 148 378
Darcy Olmos Mancilla- ATRS World Conference 2010 27 Aircraft Asset Management: Tools & airline strategies during a world market downturn
Leases South America owned Finance Operating Wet Total Gol 2005 42 42 2006 5 60 65 2007 17 94 111 2008 23 83 106 2009 33 94 127
LAN 2005 24 39 63 2006 28 48 76 2007 34 44 78 2008 42 39 81 2009 61 32 93
TAM 2005 84 84 2006 95 95 2007 115 115 2008 129 129 2009 na
Appendix D: Lease vs. purchase comparison
Operating Finance Direct Lease Lease Purchase Typical term 5 -7 yrs 12 -18 yrs Asset life Capital requirement Low Moderate High Deposits 3 months rent Moderate Significant (say 3%) c. 10% 20% + Progress payments No No Yes Repayments Rental Principal+Interest Balance due Payments made Monthly 1, 3 or 6 monthly At delivery in advance in arrears Credit rating Lowest Moderate Highest Asset exposure None Some/All Full On/off balance sheet Off Usually On On Flexibility High Low Lowest Lead time to delivery May be short May be long May be long
Darcy Olmos Mancilla- ATRS World Conference 2010 28 Aircraft Asset Management: Tools & airline strategies during a world market downturn References
Abeyratne R., (1998), The proposed International Aeronautical Monetary Fund, Journal of Air Transportation World Wide Vol 3 No 1
Airbus (2009), Global Market Forecasts 2009-2029
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Lufthansa, (2010), Aircraft Asset Management: An Airline’s Perspective, AirBusiness Academy Asset Management course 2010, Blagnac, France
Littlejohns A., (1998), Aircraft Financing, Euromoney, Oxford, England
Morell P., (1997), Airline Finance, Aldershot, England
Olmos D., (2009), Financial Crisis and Aviation Leasing Markets: The emergence of China, ATRS World Conference 2009 Paper
Pieniazek E., (2010), Aircraft Values and Asset Management, Ascend, AirBusiness Academy Asset Management course 2010, Blagnac, France
Scheinberg R., (2005), A Guide for the Perplexed: Exogenous Elements to Consider When Investing in Enhanced Equipment Trust Certificates (EETCs), New York
Stone T., Fisher R. and Lynes T., (1999), The Securitization of Aircraft Lease Receivables, Handbook of Airline Finance. McGraw-Hill, New York
Standard and Poor’s, Structured Finance, New York
Vella S., (1999), Aircraft Asset Value Management, Handbook of Airline Finance. McGraw-Hill, New York.
Darcy Olmos Mancilla- ATRS World Conference 2010 29 Aircraft Asset Management: Tools & airline strategies during a world market downturn